The impact of COVID-19 on executive pay

Our recent poll shows almost two thirds of Heads of Reward expect executive reward to change as a result of COVID-19. But opinions differ on the extent of this change.

The coronavirus (COVID-19) pandemic has highlighted a number of widely known challenges with the current structure of executive pay.

Operational restrictions and financial challenges, the widespread use of direct government support such as the Coronavirus Job Retention Scheme, as well as increasing UK unemployment rates, have amplified the debate on the quantum of executive reward.

We recently asked Heads of Reward to choose the most likely scenario for executive reward following the COVID-19 pandemic from what we saw as three key possibilities:

Scenario 1 - 2020 is a one-off year. Executive pay returns to ‘normal’ as the economy emerges from the impact of the pandemic. After some noise at 2021 AGMs on incentive outcomes based on this unique period, there is little change to the structure or implementation of pay.

Scenario 2 - The pandemic has a lasting downwards impact on the quantum of executive pay. Pensions have already been reduced, incentive outcomes for 2020 are set to be lower, and there is continued scrutiny of the pay levels of new hires for at least the next few years. This perfect storm becomes the ultimate bit of ammunition for those who have been fighting for a long-term reduction to executive pay levels in the UK.

Scenario 3 - COVID-19 triggers a radical overhaul of executive pay. Cash bonuses may be inappropriate as companies seek to preserve liquidity over the next period. The challenge of setting three year targets amidst economic uncertainty renders traditional long-term financial metrics obsolete, such as EPS, ROCE. Companies turn to alternative structures and measures, such as restricted stock plans or performance on grant (for example with an ESG underpin), to remove the need for long-term target setting.

More than 60% of the Heads of Reward expect change, either through a decline in an executive pay quantum (Scenario 2) or through a more radical restructuring (Scenario 3).

In our view, it is unlikely that the impact of COVID-19 on UK business, let alone executive pay, will be limited to the next 12 months, and there is every possibility that the quantum of pay, at least for the next few years, is curbed. While a complete overhaul of executive pay is unlikely, we would say that recent events add voice to a chorus saying the complexity, irrelevance and quantum of executive pay have gone too far. It is possible that more companies will look more broadly across their options with regards to their executive long-term incentives. Two possible options stand out:

• Introduction of restricted stock plans (RSPs) or performance on grant plans - the pandemic has created significant uncertainty over long-term business performance. RSPs and performance on grant plans avoid the challenge of setting long-term stretch targets under performance measures in the current environment. The successful introduction of RSPs at 2020 AGMs by two FTSE 100 companies and a number of FTSE All Share companies may give confidence to some remuneration committees to consider an RSP or performance on grant plan for 2021 - below Board, if not at Board, level. For Board-level RSPs, shareholders would need to be consulted over the length of the vesting period, the use of underpins, and the discount applied to the quantum of awards to reflect the greater certainty of RSPs and performance on grant.
• Reform of performance measures - a less radical approach may be to amend the performance measures used in existing performance share plans. Many directors' remuneration policies allow this, subject to consultation with shareholders. We may see a greater reliance on relative measures to avoid the challenge of setting targets for absolute measures. Alternatively, this could be the catalyst for more widespread introduction of Environmental, Social and Governance (ESG) metrics that certain shareholders have called for in recent guidance.

We’ll explore how executive pay could change in our upcoming thought leadership on this topic to be released later this summer. If you’d like to discuss this topic further, get in touch with us using the details below.